Commercial banks and investment banks are squaring off amid the Financial Accounting Standards Board decision to reassess a ruling that loan commitments aren't considered derivatives. FASB is now reassessing the ruling as a result of pressure from investment banks, including Goldman Sachs, which went on the offensive in April to convince the FASB that the definition of a derivative should apply to credit arrangements. As it stands, securities firms must account for the fair value of their loan commitments while commercial banks can keep the loans off their books, making their balance sheets appear stronger and allowing them to offer below-market rate loans.
FASB insiders said Goldman laid out "persuasive arguments" as to why more loan commitments do meet the definition of a derivative. They said they were aware of the problem banks may have with any change, but would be looking strictly at the technical aspects of the issue. The board could decide to have public discussions on the issue when it meets at the end of the month.
In a June 8 e-mail obtained by CFW, Chase officials urged counterparts at several dozen banks including First Union, PNC, Bank of New York, and Wells Fargo, to redouble their efforts at convincing the FASB that loans should not be listed as derivatives. "Unfortunately, through our involvement with certain securities industry groups, it has come to our attention that Goldman is rallying the other major securities firms to write to FASB to support their position on this," the e-mail stated. The banks did not return calls seeking comment.
The FASB's definition of a derivative is any contract that requires either no initial net investment or a smaller initial net investment than would otherwise be needed for a similar financing tool. In letter to the FASB in April, also obtained by CFW, Sarah Smith, Goldman's controller, wrote that the majority of loans do meet this definition of derivatives because the credit arrangements include a principal amount, an interest rate and little or no initial net investment.
Banks disagree because there is no market mechanism to net settle the trade of a loan. The banks argue that changing the definition would create a patchwork of accounting methods for different types of loans. Developing a system to account for the changes would take time and money and disproportionately affect smaller banks.